Overview
The Secure Act of 2019 and SECURE 2.0 Act of 2022 both provided a host of changes to individual retirement account (IRA) rules. Many of the provisions included in these Acts benefit IRA owners and promote saving for retirement. Although some provisions have a delayed effective date, many of the new rules were effective immediately. One of the Secure 2.0 Act provisions, effective upon the Act being signed into law on December 29, 2022, provides relief to individuals younger than age 59½ who correct an excess contribution by their tax return deadline, plus extensions. When a correction is done timely, net income attributable (NIA) must also be removed, and this SECURE 2.0 Act rule exempts the NIA from the 10 percent additional tax for early distribution.
What is an excess contribution?
An excess contribution occurs when an individual makes an IRA contribution that is not an eligible contribution. Examples include an IRA regular contribution that exceeds an individual’s contribution limit, an IRA regular contribution made by an individual who does not have earned income, or an excess contribution could be the result of an ineligible rollover. A note of interest is the tax law also allows an individual who made an otherwise eligible contribution to remove the contribution by his/her tax return deadline, plus extensions, using the excess contribution correction rules. This essentially allows an individual to remove a previously made contribution without any tax implications on the contribution amount.
Avoiding a penalty tax – correcting by deadline
For an IRA owner to avoid a 6 percent penalty tax on an excess contribution, he/she must remove the contribution and NIA before his/her tax return deadline, plus extensions. When considering this, Treasury Regulation Section 301.9100-2(b) provides an individual an automatic six-month extension to correct an excess contribution considering the individual previously timely filed his/her federal income tax return. Timely filed for individuals with a calendar tax year means filed by April 15, allowing them a deadline of October 15 with the automatic extension.
When an individual removes an excess contribution by his/her tax return deadline, plus extensions, NIA must also be removed, and the NIA is taxable. Prior to December 29, 2022, NIA was subject to the 10 percent additional tax for early distribution. Beginning on December 29, 2022, NIA is not subject to the 10 percent additional tax.
Example: Eleanor, age 55, has compensation of $70,000 in 2024 and made a $10,000 regular contribution to her traditional IRA on November 12, 2024. She filed her 2024 federal income tax return on April 12, 2025. Not realizing she exceeded her maximum allowable contribution of $8,000 for 2024, Eleanor deducted the entire $10,000 contribution.
Eleanor realizes her error after receiving her 2024 IRS Form 5498 in May of 2025. Eleanor subsequently withdrew the $2,000 excess contribution and NIA on June 15, 2025. The returned contribution amount is not taxable, but the NIA is taxable on Eleanor’s federal income tax return for the year in which the contribution was made (i.e., 2024). Under the previous rule, the NIA was subject to federal income tax and the 10 percent additional tax for early distribution. Under the current rule, the NIA is subject to federal income tax but is exempt from the 10 percent additional tax.
Even though Eleanor had already timely filed her federal income tax return, the automatic extension allows her to correct her excess contribution by removing it with NIA as late as October 15. She will need to amend her 2024 federal income tax return to reflect her correction of the excess contribution by revising her deducted amount and including the NIA as income.
1099-R reporting – IRS provides guidance
Since NIA is no longer subject to the 10 percent additional tax for early distribution, IRS reporting guidelines for 2024 indicate that IRA custodians should use IRS Code 2 with IRS Codes 8 or P for excess contributions with NIA distributed to individuals younger than age 59½.
